Oct 3, 2022
Lygon Explained #2: Applicants, beneficiaries and issuers
To simplify the technology and terminology behind Lygon, we are explaining the nuts and bolts that underpin our platform and the bank guarantee process.
Applicants, beneficiaries, and issuers all play a role in the bank guarantee process, whether it is in the physical or digital sense.
Different types of bank guarantees include performance-based and financial guarantees.
Below, we look at each party within the traditional, paper-based bank guarantee process and how this compares to digital bank guarantees on our platform.
Applicant: The entity needing to lodge the security, e.g. a tenant in a shopping centre.
Beneficiary: The entity holding the security, e.g. a commercial landlord.
Issuer: The financial institution issuing the security, e.g. a bank.
Applicants range from sole traders to multinational corporations.
Beneficiaries may be mum-and-dad landlords owning a single property to shopping centres, government organisations, or infrastructure such as ports and airports.
Issuers can include small local banks to international financial institutions.
What is the applicant’s role in the bank guarantee process?
Applicants require a credit facility with their bank to apply for a bank guarantee. This credit facility is used to issue bank guarantees of a certain value and is secured by either an asset or cash.
To access this, applicants pay a fee to the bank and can apply to increase or reduce the amount of their credit facility.
Applicants need to request the creation of a bank guarantee directly with their bank. As part of the request, they will include the information of the beneficiary they are providing it to, along with the amount and duration the instrument is for.
The type of guarantee will also need to be agreed upon.
Once approved, it is exchanged between the applicant and the beneficiary.
Prior to Lygon, a bank guarantee was exclusively based on paper. With paper-based instruments, they are usually delivered by hand or by secure courier.
If there are any issues when providing the bank guarantee to the beneficiary, for example, an incorrect piece of data, the process will need to be started again to obtain one with the correct information. The same also applies to an amendment.
The applicant will receive the bank guarantee from the beneficiary once the obligations have been met or the guarantee has expired.
Once received, the guarantee will be provided back to the bank, the security will be released.
What is the beneficiary’s role in the bank guarantee process?
Beneficiaries will request a bank guarantee to ensure a suitable level of security from their applicants.
They can be used to secure projects from property, goods, or contracts, to support things like construction works. They can even be used for performance milestones.
The commercial contract between the beneficiary and the applicant may contain performance-related or inflation-related clauses that will impact the terms of the bank guarantee.
Once they receive the paper instrument from the applicant, the beneficiary will then validate and store it for the duration of the guarantee.
In most instances, to keep a record of their bank guarantees, the data will be entered manually into tools like Excel to allow simpler visibility. This isn’t always the case though, and often, the records of how many guarantees they hold can be incomplete.
Sometimes, the physical instruments are stored outside of the beneficiary's head office.
They are usually placed in secure storage facilities, such as fireproof safes, or under lock and key. However, they can also be stored in the top drawer of a project manager's desk.
This can be a problem, as often teams are unsure of where certain guarantees are stored.
When they aren’t stored safely, we have seen examples of paper instruments that are lost, or damaged by floods and fire. A lack of secure storage also means these documents can be tampered with, and in some cases, used in fraudulent activity.
The guarantees are kept until they expire, or a project is completed, and they need to be cancelled.
In all these scenarios, the paper bank guarantee needs to be provided back to the applicant by post or delivered by hand.
When a demand on a guarantee is made, the beneficiary attends the branch of the bank in person.
How do issuers manage their customers' bank guarantee book?
The bank manages the credit facility limits of its customers. It is their job to make sure they are not over-exposed, and the security to support the bank guarantee facility remains in place.
The bank will retain a record of the bank guarantee and the credit facility associated with it.
Once the guarantee has been returned to the bank, they will either reduce the exposure or discharge the security of the credit facility.
A demand on the guarantee is paid after due diligence checks have been made on the day the bank guarantee is returned to the bank.
Payment on the demand can be in the form of a bank cheque or a transfer to a bank account depending on the issuer.
How did Lygon Arc streamline this process for each counterparty?
Each counterparty had issues with the paper bank guarantee process.
Many of these issues were linked to the paper nature of the financial instruments themselves.
Storage, delivery, fraud, and damage were considerations for all parties when starting the process and relying on the issuance of a guarantee.
The fact these documents couldn’t be amended without significant wait times was another headache associated with the paper process.
Whilst a digital alternative seems the obvious replacement, there were some hurdles in the way which needed to be resolved before the process could be streamlined.
Collaboration between the big four Australian banks and legal representatives was required to complete Lygon’s standardised terms before digital instruments could be issued.
After a few years of research and development, the Lygon Arc platform launched in 2021, solving many of the issues that counterparties faced with paper immediately.
The digitisation of the process meant the issues around delivery, storage and management of these instruments were solved instantly.
Applicants could now apply for bank guarantees online and would have full visibility over the instruments as they worked their way between counterparties.
Beneficiaries could rest assured that all guarantees would be legitimate. They also no longer require manual tracking and reporting, or rely on secure storage to house paper instruments.
Issuers now have visibility over all their guarantees in circulation and can give customers a better, more efficient experience whilst applying for a bank guarantee.
The need to physically distribute paper is eliminated, and the use of blockchain means all instruments sit on a distributed ledger, reducing the risk of fraud.
Finally, the ability to amend guarantees online without starting the process again has already saved countless pieces of paper, and thousands of days in time delays.
Lygon has onboarded market-leading organisations as applicants, beneficiaries, and issuers since we launched the Arc platform back in 2021, and we are proud to see digital guarantees becoming the preferred method of security.
For more information on Lygon and digital bank guarantees, get in touch by filling in the form on our "contact" page.
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Paper vs digital: The hidden costs of the paper bank guarantee lifecycle
Lygon Explained #1: The bank guarantee process